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Multinational vs. domestic financialmanagement
Exchange rates and trading in
foreign exchange International monetary system International money and capital
markets
CHAPTER 16Multinational Financial Management
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What is a multinational corporation?
A corporation that operates intwo or more countries.
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1. To seek new markets.
2. To seek raw materials.3. To seek new technology.
4. To seek production efficiency.
5. To avoid political and regulatoryhurdles.
6. To diversify.
Why do firms expand into other
countries?
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1. Different currency denominations.2. Economic and legal ramifications.
3. Language differences.
4. Cultural differences.5. Role of governments.
6. Political risk.
What are the six major factors that
distinguish multinational fromdomestic financial management?
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U.S. $ to buy1 Unit
Japanese yen 0.009Australian dollar 0.650
Are these currency prices direct orindirect quotations?
Since they are prices of foreigncurrencies expressed in dollars,they are direct quotations.
Consider the following exchange rates:
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The number of units of foreign
currency needed to purchase oneU.S. dollar, or the reciprocal of adirect quotation.
What is an indirect quotation?
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Calculate the indirect quotations
for yen and Australian dollars.
# of Units of Foreign
Currency per U.S. $Japanese yen 111.11Australian dollar 1.5385
Yen: 1/0.009 = 111.11.A. Dollar: 1/0.650 = 1.5385.
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The exchange rate between any
two currencies. Cross ratesare actually calculated on thebasis of various currenciesrelative to the U.S. dollar.
What is a cross rate?
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Cross rate = x
= 111.11 x 0.650= 72.22 yen/A. dollar.
Cross rate = x
= 1.5385 x 0.009= 0.0138 A. dollars/yen.
Calculate the two cross rates
between yen and Australian dollars.
Yen U.S. DollarsU.S. Dollar A. Dollar
A. Dollars U.S. DollarsU.S. Dollar Yen
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The two cross rates arereciprocals of one another.
They can be calculated by dividingeither the direct or indirectquotations.
Note:
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Price = (1.75)(1.50)(111.11)
=291.66 yen.
A firm can produce a liter of
orange juice and ship it to Japan for$1.75. If the firm wants a 50% markupon the product, what should the
juice sell for in Japan?
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250 yen = 250(0.0138) = 3.45 A. dollars.
63.45 = 2.55 Australian dollar profit.1.5385 A. dollars = 1 U.S. dollar.
Dollar profit = 2.55/1.5385 = $1.66.
Now the firm begins producing the
orange juice in Japan. The productcosts 250 yen to produce and shipto Australia, where it can be soldfor 6 Australian dollars. What is
the U.S. dollar profit on the sale?
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The risk that the value of a cash flowin one currency translated to another
currency will decline due to a changein exchange rates.
For example, in the last slide, a
weakening Australian dollar(strengthening dollar) would lower thedollar profit.
What is exchange rate risk?
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The current system is a floating rate
system.Prior to 1971, a fixed exchange rate
system was in effect.
The U.S. dollar was tied to gold.
Other currencies were tied to thedollar.
Describe the current and former
international monetary systems.
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The European Monetary Union
In 2002, the full implementation of theeuro is expected to be complete.
The national currencies of the 12participating countries will be phasedout in favor of the euro. The newly
formed European Central Bank willcontrol the monetary policy of theEMU.
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A currency is convertible when the
issuing country promises toredeem the currency at currentmarket rates.
Convertible currencies are traded inworld currency markets.
What is a convertible currency?
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It becomes very difficult for multi-national companies to conductbusiness because there is no easyway to take profits out of the country.
Often, firms will barter for goods toexport to their home countries.
What problems arise when a firmoperates in a country whosecurrency is not convertible?
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Spot rates are the rates to buy
currency for immediate delivery.
Forward rates are the rates to buycurrency at some agreed-upon date
in the future.
What is the difference between
spot rates and forward rates?
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When is the forward rate at a premium
to the spot rate?
If the U.S. dollar buys fewer units of aforeign currency in the forward than inthe spot market, the foreign currencyis selling at a premium.
In the opposite situation, the foreign
currency is selling at a discount.The primary determinant of the
spot/forward rate relationship isrelative interest rates.
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No.
ft = $0.0095
kh= 4%/12 = 0.333%kf= 4%/12 = 0.333%
(More...)
Assume 1 yen = $0.0095 in 30-day
forward market and kNomfor 30-dayrisk-free securities in Japan and U.S.= 4%. Does interest rate parity hold?
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Therefore, if interest rate parity holdsthen e0= $0.0095. However, we weregiven earlier that e0= $0.0090.
.1e
0095.0$
0033.1
0033.1
e
0095.0$
k1
k1
e
f
0
0
f
h
0
t
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What security offers highest return?
Japanese security.1. Convert $1,000 to yen in spot market. $1,000
x 111.111 = 111,111 yen.2. Invest 111,111 yen in 30-day Japanese
security. In 30 days receive 111,111 yen x1.00333 = 111,481 yen.
3. Agree today to exchange 111,481 yen 30 daysfrom now at forward rate.
111,481/105.2632 = $1,059.07.4. 30-day return = $59.07/$1,000 = 5.907%,
nominal annual return = 12 x 5.907% =70.88%.
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What is purchasing power parity (PPP)?
Purchasing power parity implies that
the level of exchange rates adjusts sothat identical goods cost the sameamount in different countries.
Ph= Pf(e0) or e0= Ph/Pf.
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If grapefruit juice costs $2.00/liter inU.S. and PPP holds, what is the price
of grapefruit juice in Australia?
PPP = e0= Ph/Pf$0.6500 = $2.00/Pf
Pf= $2.00/$0.6500
= 3.0769 Australian dollars.
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Lower inflation leads to lower interest
rates, so borrowing in low-interestcountries may appear attractive tomultinational firms.
However, currencies in low-inflation
countries tend to appreciate againstthose in high-inflation rate countries, sothe effective interest cost increases overthe life of the loan.
What impact does relative inflationhave on interest rates and
exchange rates?
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Eurodollar marketsa source of dollars outside the U.S.
International bondsForeign bonds: Sold by foreign
borrower, but denominated in the
currency of the country of issue.Eurobonds: Sold in country other
than the one in whose currency thebonds are denominated.
Describe the international
money and capital markets.
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To what extent do average capitalstructures vary across different
countries?
Previous studies suggested thataverage capital structures varyamong the large industrial countries.
However, a recent study, whichcontrolled for differences in
accounting practices, suggests thatcapital structures are more similaracross different countries thanpreviously thought.
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Distances are greater.
Access to more markets for loansand for temporary investments.
Cash is often denominated indifferent currencies.
What is the impact of multinationaloperations on each of the
following topics?
Cash Management
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Foreign operations are taxed locally,and then funds repatriated may be
subject to U.S. taxes.
Foreign projects are subject topolitical risk.
Funds repatriated must be convertedto U.S. dollars, so exchange rate riskmust be taken into account.
CapitalBudgetingDecisions
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Credit is more important, because
commerce to lesser-developedcountries often relies on credit.
Credit for future payment may be
subject to exchange rate risk.
Credit Management
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Inventory decisions can be more
complex, especially when inventorycan be stored in locations in differentcountries.
Some factors to consider areshipping times, carrying costs, taxes,import duties, and exchange rates.
Inventory Management
